AEM Holdings Ltd - CGS-CIMB Research 2019-04-30: 2019 Getting Priced In

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AEM HOLDINGS LTD (SGX:AWX)

AEM Holdings Ltd - 2019 Getting Priced In

• AEM HOLDINGS LTD (SGX:AWX) has raised its FY19 revenue guidance to between S$225m and S$250m. Orders received for delivery in FY19 now stands at S$209m.
• We raise our FY19F net profit by 25% to reflect the latest guidance. We think FY19 will still see y-o-y profit decline as experienced hires are added.
• Maintain HOLD. Higher Target Price of S$1.21 on unchanged 10x FY20F EPS.

AEM ups FY19 revenue guidance

• When AEM announced its 1Q18 results on 24 Apr 2018, the company guided that it was expecting FY18 revenue and pre-tax profit of at least S$255m and S$42m respectively. Pre-tax margin implied by this guidance was 16.47%. Orders received for delivery in FY18 at that juncture was S$192m.
• As of 25 April 2019, AEM announced that it has received sales orders worth S$209m for delivery in FY19. FY19 revenue guidance was between S$225m and S$250m. No guidance was issued with regards to the profit expectation for FY19.
• See AEM's announcements.

What’s good for Intel is good for AEM

• Based on our checks and media reports, AEM’s major customer is Intel Corp (INTC US, Not Rated). The key short-term negative news on Intel that could pose short-term headwinds for AEM are:
  1. Intel announced (16 Apr 2019) its intention to exit the 5G smartphone modem business. The company does not expect to launch 5G modem products in the smartphone space, including those originally planned for launches in 2020.
  2. In its 1Q19 results commentary (25 Apr 2019), Intel guided that 2Q19 revenue could decline 8% y-o-y while FY19 revenue could fall 3% y-o-y to US$69bn (down US$2.5bn from its previous guidance of US$69bn). However, we are relieved that Intel left its capex guidance of US$15.5bn for FY19 unchanged.
• What is more important for AEM is that Intel remains an industry leader and has the vision to expand its Total Addressable Market (TAM) beyond its core strength in computing. Based on Intel’s 2018 Annual Report, the company sees a TAM opportunity of US$300bn for the group to participate in by 2022.
• Based on Intel’s disclosure, some examples of possible new demand drivers include:
  1. Autonomous driving via the EyeQ series of chips from Mobileeye ;
  2. 9 Apr 2019 announcement by Intel and Google Cloud on a strategic partnership aimed at helping enterprise customers seamlessly deploy applications across on-premise and cloud environments. Intel and Google Cloud will collaborate on Anthos, a new reference design based on the 2nd-Generation Intel® Xeon® Scalable processor and an optimized Kubernetes software stack that will deliver increased workload portability to customers who want to take advantage of hybrid cloud environments.
  3. 2 Apr 2019 announcement of a brand-new product family, the Intel® Agilex™ FPGA (see Figure3 in attached PDF report). This is a new family of field programmable gate arrays (FPGA) that will provide customized solutions to address the unique data-centric business challenges across embedded, network and data center markets.
  4. 1Q19 results (25 Apr 2019) commentary that its first high-volume 10nm processor, code-named Ice Lake, remains on track to be in volume systems on retail shelves for the 2019 holiday selling season.
  5. Intel will also expand its plant in Israel (Reuters reported on 29 Jan 2019 that Intel could invest US$10bn) and has begun site expansion projects in Ireland and its US plant in Oregon 2019 as it looks to diversify its products for a broader set of customers, such as auto safety and wireless connections for mobile phones.

Progress in non-Intel business

Afore

• On 4 March 2019 Afore (An AEM Company), unveiled a new cryogenic tool, which is developed to make full 12” wafer probing at cryogenic temperatures below 4 Kelvin possible. This new first-of-its-kind tool was developed with Bluefors, a market leader of cryogen-free dilution refrigerator systems.
• Afore mentioned that its customer, Intel, identified the need for a quantum testing tool to collect more data about quantum chips called “qubits.” This new tool allows up to 100 times faster throughput in sample characterization and Afore foresee that it will dramatically help speeding up the developments of cryogenic quantum devices, electronics and detectors.
• We do not expect any significant earnings impact from this but it does highlight Afore’s capabilities.

Huawei

• On 9 Oct 2018, AEM announced that Huawei (Unlisted) has chosen AEM’s test solution (via its acquisition of Inspirain Technologies Pte Ltd) developed in collaboration with China Electronics Technology Group Corporation No.23 Research Institute (“CETC23”) for qualifying high-performance short reach cabling links for Huawei’s 5G backhaul network. AEM will deliver the first test solution for testing 100Gbps links for Huawei’s short reach 5G backhaul network in 2019.
• On 24 April 2019, AEM announced that its multimode fiber optic bandwidth test solution WideOptix-SR4 has passed acceptance test by Huawei. With this acceptance, AEM has also received its first prototype purchase order for the system.
• Other than Huawei, The TestPro CV100 Multifunction Cable Tester has also been approved to certify cabling systems from leading cabling providers including Panduit, Seimon, Hitachi Cable America, Belden, Hubbell, Paige Datacom Solutions, Signamax, Superior Essex. Contractors looking to certifying physical infrastructure from these vendors can now use TestPro to fully protect and warranty work.
• AEM’s TestPro CV100 Multifunction Cable Tester also received the Security Industry Association’s (SIA) award for Best Design, Diagnostic and Installation Tool at the 2019 New Product Showcase Awards.

2019 earnings revised up 25%

• Taking AEM’s latest guidance and the latest developments at the company and its key customer, we have raised our FY19-21F forecasts. We would place less weight on our FY21F as the nature of the business is order driven.
• We also performed a scenario analysis in Figure 10 (see attached PDF report) on the possible net profit outcomes for FY19 based on AEM’s guidance and its historical performance.

1Q19 expectations

• AEM is scheduled to release its results on 7 May 2019. Based on the historical performance in FY17-18, we think net profit for 1Q19 could fall 34% y-o-y but grow 24% q-o-q.
• The first quarter is typically not the strongest quarter for AEM.

Start thinking about 2020

• The difficulty in forecasting AEM’s earnings potential is the order driven nature of the business which is currently being driven by one major customer. To recap, the dim visibility into 2019 commentary issued in its 2Q18 results release has now given way to a FY19 revenue guidance of between S$225m and S$250m with orders received for delivery in FY19 worth S$209m.
• The same issue of the potential order for delivery in FY20 crops up again as we move further into FY19.
• The current positives are that Intel has made clear its intention to grow its TAM and AEM is making headways in growing its other business. We believe there will be further acquisitions from AEM to strengthen its other businesses.

How should AEM be valued

• We have consistently ascribed a 10x P/E multiple in valuing AEM. This 10x P/E multiple implies a 10% discount to its main customer Intel’s P/E of 11.1x as well as a 19% premium to its former competitor, Cohu.
• An alternative way to look at AEM is to consider the potential book value of the company over a certain time frame. See Figure 14 in attached PDF report.

Maintain HOLD, higher Target Price of S$1.21

• On an unchanged 10x P/E multiple (in line with the sector average), our Target Price is revised upwards to S$1.21.
• Downside risks to our call are order cancellations/delays by its major customer while upside earnings risk comes from stronger-than-expected orders from its major customer.
• For us to justify an ADD call, we need AEM to deliver a minimum FY20F net profit of S$34.3m (see Figure 17 in attached PDF report). In our 4Q18 results notes, we highlighted that for such a scenario to unfold, AEM would need :
  1. its major customer to continue launching new successful products;
  2. strong demand for AEM’s new hybrid solutions product;
  3. successful growth of its 5G cable tester market and
  4. new customer wins by Afore.

William TNG CFA CGS-CIMB Research | https://research.itradecimb.com/ 2019-04-30

SGX Stock Analyst Report HOLD MAINTAIN HOLD 1.21 UP 1.110